Investment tax credits for Canadian real estate entities

Executive summary: Leveraging Canadian investment tax credits and the U.S. Inflation Reduction Act for tax advantages in real estate

Amid elevated interest rates and the rising costs of capital, Canadian real estate is encountering challenges that have resulted in reduced transaction volumes and raised concerns about project feasibility. The Canadian real estate sector may be able to utilize tax incentives provided by both the U.S. Inflation Reduction Act and Canada’s newly proposed Investment Tax Credits (ITCs) to improve return on investment, reduce the payback period, and even create new revenue streams.

Investment tax credits for Canadian real estate entities: harnessing Canada’s ITCs and the U.S. Inflation Reduction Act for tax advantages

Canadian real estate companies face challenges amid a higher interest rate environment and increased capital costs, leading to reduced transaction volumes and project feasibility concerns. Chief financial officers can help ease margin compression by leveraging ITCs and incentives.

Although tax benefits are limited for some real estate entities such as real estate investment trusts (REITs) and tax-exempt investors, for others it may be worth conducting a feasibility study to determine potential benefits to incorporate into underwriting. Increasingly, governments are promoting sustainability practices of businesses by enhancing monetary incentives for corporate decision making that promotes green energy, energy transition and decarbonization. With growing stakeholder interest in environmental, social and governance (ESG) initiatives, the sector should, at a minimum, explore the applicability of U.S. and Canadian ITCs that may amount to significant tax savings.

U.S. Inflation Reduction Act

Canadian real estate asset managers may benefit from provisions of the U.S. Inflation Reduction Act (IRA) of 2022. The IRA provides $369 billion in incentives to encourage domestic investment in renewable technologies and clean energy. The legislation amended four sections of the U.S. Internal Revenue Code that are of particular interest to the real estate industry

• Section 179D outlines deductions for energy-efficient commercial building property placed in service during the year. The scope includes interior lighting systems; heating, ventilation and air conditioning; and building envelope improvements. The IRA reduced from 50 per cent to 25 per cent the overall energy cost reduction required to qualify for deductions for tax years beginning on or after Jan. 1, 2023. Certification is essential to prove the energy cost reduction. For 2023, section 179D may yield a deduction as high as 54 cents to $1.07 per square foot when the qualifying building systems create energy savings of 25 per cent or more, increasing by 2 cents for each percentage point over 25. Note the amount of the deduction is indexed to inflation. Prevailing wage and apprenticeship requirements must be met for the maximum deduction. Retrofits on qualifying properties are eligible; however, the deduction is allowed in the year of the qualifying certification, not in the year the property is placed in service.
• Section 48 outlines the ITC for energy property placed in service, including solar panels. The credit rate, based on a percentage of the basis of the energy property, is up to 30 per cent if certain labor requirements are met. Additional credit adders apply for projects using domestic content or located in an energy community or low-income community. The credit is technology-neutral after 2024 and transferable after 2022. Financing with tax-exempt bonds may reduce the credit.
• Section 30C pertains to alternative fuel vehicle refueling property, including credits for electric charging stations. Eligible for transferability and direct pay, the credit applies to property placed in service before 2033, with a requirement for placement in nonurban locations after 2022. In urban areas, eligibility is contingent on being in a new market tax credit area. The credit is up to 30 per cent of the property's eligible basis, if prevailing wage and apprenticeship criteria are met, with a maximum credit amount of $100,000 for depreciable property.
• Section 45L introduces the new energy-efficient home credit for eligible contractors that build and sell an energy-efficient dwelling. Leasing can qualify as selling. A credit of up to $2,500 credit applies to energy-efficient multi-family homes meeting Energy Star requirements, and up to $5,000 for multi-family homes certified under the U.S. Department of Energy's Zero Energy Ready Home Program, if prevailing wage and apprenticeship requirements are met. Notably, the credit is nontransferable. For single family homes, the prevailing wage and apprenticeship requirements are not required to claim these credit amounts.

The section 30C alternative fuel vehicle refueling property credit and the section 48 ITC can now be sold under the section 6418 transferability rules. Proceeds from the sale of these credits are not taxable, which means they do not constitute “bad” income for REITs. A section 179D deduction is now fully deductible against earnings and profits. For affordable housing, the section 45L credit and the section 48 ITC do not reduce the section 42 eligible basis.

Canada’s clean technology ITC

The clean technology ITC (CTITC), introduced in Canada’s 2022 Fall Economic Statement, offers a refundable credit on the capital cost of eligible equipment. Generally, eligible property includes equipment that generates or stores renewable energy, as well as non-road zero emission vehicles. The ITC is exclusive to taxable Canadian corporations which own eligible property directly or through a partnership and mutual fund trusts that are REITs. The credit is 30 per cent for property acquired on or after March 28, 2023, and before Jan. 1, 2034; is 15 per cent for property acquired after Dec. 31, 2033 and before Jan. 1, 2035; and ceases thereafter. Failure to meet labour requirements could result in a 10 per cent reduction in the credit. Generally, the labour requirements involve electing in a prescribed form and meeting prevailing wage and apprenticeship requirements.

Canada’s carbon capture, utilization, and storage ITC

The ITC for carbon capture, utilization and storage (CCUS), announced in Budget 2021, is applicable to the storage of captured carbon in geological storage and use of captured carbon in producing concrete. For qualified expenditures incurred after 2021 and before 2031, ITC rates vary from 37.5 per cent to 60 per cent, depending on the type of expenditure. Similar to the CTITC, failure to satisfy labour requirements will reduce the amount of the credit by 10 per cent.

Canada’s clean hydrogen ITC

The clean hydrogen ITC (CHITC) is a proposed (announced in Budget 2023) refundable ITC, that will refund up to 40 per cent of the capital cost of eligible clean hydrogen property. The CHITC applies to property that is acquired, and available for use in a qualifying project, between March 28, 2023 and Dec. 31, 2034 (inclusive). A qualified project involves the production of hydrogen from electrolysis or natural gas reforming where greenhouse gas emissions are limited using carbon capture technology. . The CHITC will be subject to the same labour requirements as the CTITC and the CCUS ITC.

Canada’s clean electricity ITC

Proposed in Budget 2023, the Clean Electricity ITC (CEITC) is a 15 per cent refundable tax credit that would apply to equipment used for electricity generation, stationary electricity storage, and transmission of electricity between provinces and territories. The credit would be available for taxable and non-taxable Canadian corporations where they acquire eligible property and that property becomes eligible for use as of the date of Budget 2024 (released on April 16, 2024) for projects that did not begin construction before March 28, 2023. The credit would end after 2034 and be subject to the same labour requirements as described above with a failure to meet these resulting in a rate of 5 per cent.

Impact for real estate entities

Increasingly, real estate entities include tax incentives related to green energy in their corporate tax planning, affording them not only tax savings, but also the opportunity to achieve ESG goals to meet the evolving expectations of their stakeholders. The Canadian real estate sector may be able to utilize tax incentives provided by both the U.S. IRA and Canada’s newly proposed ITCs. These incentives can improve return on investment, reduce the payback period, and even create new revenue streams, such as when REITs sell credits.

RSM Canada’s tax professionals can leverage a depth of knowledge across lines of business to assess your current inventory of assets and identify strategies that incorporate Canadian clean energy solutions into your tax planning process.